Wall Street analysts expect that by 2015 the biggest medical contract research organizations, or CROs, will dominate a market that reached $28 billion worldwide last year. That’s good news for companies like Covance (NYSE:CVD), Pharmaceutical Product Development (Nasdaq:PPDI), Ireland-based ICON (Nasdaq:ICLR), Parexel (Nasdaq:PRXL), Charles River (NYSE:CRL) and Chinese firm Wuxi Pharmatech (NYSE:WX).
What still remains to be seen, however, is just how profitable the business will be for the companies that perform the research and development work for Big Pharma.
CROs and their investors had to be encouraged when the final sales figures from 2010 were tallied. They showed that revenue in the contract research business was up about 15% from a year earlier. That was certainly a welcome relief for an industry that has undergone a major upheaval as Big Pharma cut or delayed research and development budgets and activities during the past several years.
For CROs, though, there was a huge dark cloud in the silver lining: While sales were up nicely, profits dipped – as much as 50% at some firms.
Some industry experts predict profits will continue to be hard to come by now that the relationship between pharmaceutical companies and CROs is changing dramatically. Rather than simply outsourcing R&D projects as in the past, large pharmaceutical firms have opted for strategic alliances. Such linkups may prove more advantageous for Big Pharma than its CRO partners.
For example, analysts have pointed to the deals that ICON and Parexel made with Pfizer (NYSE:PFE), which is slicing billions from its R&D budget. David Windley, an equity analyst with Jefferies, said Parexel ‘s deal with Pfizer is just one of many strategic alliances the company has and he’s uncomfortable about the underlying cost of some of the relationships. “Pfizer is more likely to transition projects in most need of help, which translates to lots of cleanup and an extra challenge to the relationship kick-off,” he stated.
ICON CEO Peter Gray acknowledges that costs will go up as the company hires 600 to 800 people to handle the increased workload. But he is committed to making the Pfizer relationship work and confident that it will help accelerate ICON’s growth.
Pfizer is following in the footsteps of other members of Big Pharma like Sanofi (NYSE:SNF), which has teamed up with Covance. To give themselves a better chance to snag exclusive deals with Big Pharma, CROs are likely to consolidate to gain the size and efficiency.
Perhaps that’s what motivated Pharmaceutical Product Development, the third-largest CRO in terms of revenue, to announce recently that it is looking at its long-term plan and capital structure to see if there are any actions, which might create value. This news is driving speculation that the company was putting itself up for sale.
The move seemingly startled the industry because the company was seen more as a buyer than a seller. Maybe management wants to get out while the getting is good. Rumors persist that the buyer is not another CRO but a private equity firm — and that Pharmaceutical Product Development could fetch $35 a share, a 16% premium from where it now trades.
At the time of publication, Barry Cohen didn’t hold any of the stocks mentioned in this article.
